Can Minnesota Reward Job Creation?

January 11, 2010
By
Nathan Paine, Fellow

In recent years here in Minnesota, state government's efforts to stimulate job creation have come in the form of broad-based tax breaks to business if they agree to re-locate or stay here. While the tax breaks might be an enticement for a company to move or keep its operation in Minnesota, there's no absolute promise that company will create family-sustaining jobs. There is, however, one idea that could deliver on new jobs and has already worked in Minnesota once before.

They're called a wage subsidies and a number of economists have recently proposed using them to create additional jobs in the economy. Essentially, all wage subsidy programs aim to create additional jobs by subsidizing the employer's cost of labor. The various proposals have in common the goal of employing the persistently unemployed; clearly a worthy goal in a tough economy. In the 1980s, Minnesota implemented the Minnesota Emergency Employment Development (MEED) program. The MEED program was successful at creating permanent jobs for low-skilled workers. About 80 percent of the program participants retained their jobs at least 60 days after the subsidy period ended. This statistic is not surprising since we know that employment augments the skills and human capital of workers making them more productive. Most of these jobs by the second year of the program were created in the private sector. The MEED program represents a successful partnership between the public and private sectors to create jobs for the chronically unemployed.

The goal of a wage subsidy program is predicated on the marginal productivity theory that the profit maximizing firm will only hire an additional worker if the worker produces additional revenue that exceeds the wage paid to the worker. One problem facing policymakers in designing and implementing a wage subsidy program concerns weighing the trade-off between program costs and the size of the financial incentive offered to companies to increase employment. One solution is to offer the wage subsidy to only newly hired employees. Nearly all these proposals restrict wage subsidies to new hires. Most wage subsidy proposals also limit program costs by restricting the wage subsidy to new workers that earn below a target wage rate. Workers earning more than the target wage rate do not qualify for the wage subsidy. Typically, the subsidy payment is equal to a percentage of the difference between the target wage and the hiring wage.

It is important to recognize that wage subsidy programs have numerous positive and negative aspects. The biggest positive impact is these programs provide the largest stimulus to employment for workers who are persistently unemployed and are the lowest paid in the labor market. A corresponding advantage is that subsidies are reduced as the worker's wage increases with experience and training. There are also several negative aspects to worker subsidy programs apart from the transfer of public dollars to the private sector. Wage subsidy programs may provide employers with incentives to reduce full-time positions in favor of part-time positions. An employer may also replace higher wage employees with lower wage employees. To the extent that the wage subsidy program creates incentives for this behavior, the net jobs created will be reduced. Moreover, to the extent that firms view the subsidy to be temporary, the impact of the wage subsidy program will be lessened.

Fundamentally, policymakers will need to weigh the cost of a wage subsidy program against the jobs created. The effectiveness of a wage subsidy program depends crucially on the elasticity of the labor demand curve. The elasticity is simply the percentage change in employment divided by the percentage change in wages. The more inelastic the labor demand curve, the smaller will be the net increase in employment for any given amount of subsidy per worker. A highly inelastic labor demand will therefore result in a high program cost with not much bang for the buck in terms of job creation.

Most studies suggest modest positive employment effects from wage subsidy programs. Wage subsidy programs with job development and training components appear to be somewhat more successful in improving the employment opportunities of persistently unemployed workers in targeted groups. The federal government is probably the only entity with the resources to fully fund a wage subsidy program of the magnitude needed to address the high and persistent unemployment in this economy. It would be best to pursue this policy in concert with local job development and training programs if administratively feasible to maximize the benefits and create synergies.

Both the United States and Minnesota need to adopt policies that directly address job creation during this recession rather than focusing on supply side factors that are only relevant in the long term. A wage subsidy program if structured properly would support private sector employment by offering financial incentives and mitigate the negative features to a large extent. Long term unemployment also creates long term damage, too. Therefore, while the primary objective should be to grow GDP pie, policies should also be adopted that aim to increase employment in the short-term. At the very least, wage subsidy programs should be considered. Importantly, these programs are not without precedent. There is an abundance of experience that we can learn from when designing these programs so as to maximize the bang for a buck. Minnesota and the United States can look to the MEED program for guidance and evidence of the numerous positive benefits of wage subsidy programs. Moreover, the wage subsidy program will also stimulate aggregate demand and investment in the private sector which would add to the momentum from a better than expected holiday shopping season.

The attitude that the jobs will come if we grow GDP is appropriate for the long-term, but it is also critical to adopt short-term policies (e.g. government investments to stimulate aggregate demand) that are appropriate to stabilize an economy in recession.